US senators draw a bead on Bitcoin

Two US senators have called on American authorities to crack down on the Bitcoin peer-to-peer online virtual “currency” after discovering it’s being used, rather like greenbacks in personal transactions, to buy drugs anonymously.

Bitcoin uses a decentralized model: users exchange Bitcoins directly between each other in encrypted, digitally-signed transactions. It touches the “real” economy only where an individual is willing to shoulder the risk of exchanging Bitcoins for currencies.

Because exchange markets exist, Bitcoins have attracted sufficient “real” value to buy and sell real-world goods and, according to Democrat senators Charles Schumer (New York) and Joe Manchin (West Virginia), one application of Bitcoin has been to buy drugs.

The pair have written to US Attorney General Eric Holder and Drugs Enforcement Administration (DEA) chief Michele Leonhart calling for action against Bitcoin and the online drug marketplace Silk Road.

Bitcoin had only recently started attracting mainstream attention, and was shot into the spotlight by a Gawker article describing its use on Silk Road.

Gawker later pointed out the appreciating value of Bitcoins once people realized they could be exchanged for dope.

Since P2P networks are difficult to shut down, the obvious point of attack would be the bank accounts of individuals who trade Bitcoins for currencies. Such action, however, would require international cooperation since account-holders could live anywhere.

The DEA is unlikely to be the last time Bitcoin attracts unwanted government attention. New Scientist recently noted (login required) the likelihood that tax agencies will want to get a handle on it, quoting Her Majesty’s Revenue & Customs as saying that turning Bitcoins into currency could make transactions taxable.

If traced by the Australian Tax Office, Bitcoins would probably get the same treatment as “barter” exchanges, with tax assessed on the value of traded goods or services.

'Ponzi scheme'

Bitcoin has also been criticized as having the characteristics of a Ponzi scheme.

New users acquire the currency by running the software on their computers, and occasionally “striking it lucky” when they discover the number of the next Bitcoin to be issued.

Over time, the Bitcoin algorithm is designed to slow down the rate at which new Bitcoins are issued – which means early adopters were able to amass more coins more quickly than today’s user; and, if the network continues to grow, today’s user will amass more of the currency than someone who joins the network two years from now.

This gives all current users a vested interest in promoting the system to the next round of participants.

The architecture therefore encourages boosterism such as this article from Rick Falkvinge, who can tell users to get on board even though this would lift the value of his own Bitcoin buy-in (Falkvinge quite cheerfully tells his readers “as more people exchange national currencies for Bitcoin, the value of one Bitcoin rises).

It looks like Bitcoin’s evangelists have over-reached: by mainstreaming the Bitcoin story, they’ve also ensured it's going to come under the kind of national scrutiny they hoped to avoid. ®